A Big Risk for Apple Inc. Stock

By Ashraf Eassa Markets Fool.com

After Apple (NASDAQ: AAPL) reported lukewarm second quarter results and guidance for its third quarter, the company's stock price dipped a smidgen. A few days after reporting, though, Apple stock hit a new 52-week high of $148.98, closing at $148.96 per share at the end of the Friday, May 5 trading session.

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Why did Apple stock reverse its losses and then some after earnings? Allow me to offer up my take on the matter and, based on that, discuss a potential risk to Apple stock.

Does anybody care about the current cycle?

Even before Apple launched the iPhone 7-series devices, I don't think expectations for it were particularly high. Sure, the lineup offered several interesting technical advancements over the prior generation iPhone 6s/6s Plus devices (particularly the iPhone 7 Plus relative to the iPhone 6s), and the devices are generally very good.

However, there was likely an expectation out there that without a dramatic redesign of the device and/or substantial new features, the iPhone 7-series cycle wouldn't be anything close to a "super cycle."

Image source: Apple.

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And, indeed, that's how it has been playing out. Apple reported 5% iPhone unit and revenue growth in the first quarter of its current fiscal year, and most recently it reported 1% year-over-year iPhone revenue growth on a 1% decline in iPhone unit shipments.

The iPhone 7 cycle just isn't proving to be much of an improvement over the iPhone 6s cycle, which itself fared poorly against the iPhone 6 "super cycle."

However, I think that all of this has been and continues to be largely baked in; if the iPhone 7-series devices keep the iPhone business roughly stable until the next-generation iPhone 8 (which is expected to offer substantial technical and aesthetic enhancements), I don't think Apple investors care too much about a few percentage points' worth of iPhone unit shipment/revenue growth either way.

The expectations around the next generation of iPhone models -- particularly the premium OLED version -- are an entirely different matter.

Expecting a "super-cycle"

At this point it seems that the investment community is largely expecting the upcoming OLED iPhone (as well as, to a much lesser extent, the refreshed iPhone 7s/7s Plus) to help drive a so-called "super-cycle."

Indeed, it's hard not to be excited about the possibility that Apple could see not only unit shipment increases in the coming cycle (the new OLED iPhone could help give Apple's slumping performance in Greater China a much-needed boost, for instance), but that the new phones could help drive Apple's iPhone average selling prices up.

You don't need to be a financial whiz to see that higher average selling prices coupled with higher unit shipments is a potentially awesome combination.

So, what's the risk, then? Simple: if the entire investment community is expecting great things and those great things are priced into the stock, then when the new product cycle starts, it's reasonable to expect one of three possible outcomes:

  1. Apple's "super-cycle" leads to revenue and profit levels that even the most bullish forecasts from analysts covering the stock as well as the major institutional investors didn't expect, driving the stock up.
  2. Apple's "super-cycle" comes in as expected and investor focus potentially shifts to "what comes after the big super-cycle?"
  3. Apple's "super-cycle" isn't as "super" as many investors expect, leading to investor disappointment and a potentially significant drop in the stock price.

Given the hype around the new iPhone models, I wouldn't peg the odds of option one playing out as particularly high; options two and three each seem substantially more likely than option one and neither of them is exactly a reason to get excited about buying Apple stock after the nearly 30% gain the shares have delivered year-to-date (this is huge for a company of Apple's size).

Apple is a great company and I'm personally quite excited for this year's product launches, but given the move in the stock price year-to-date, it seems that the market is, too, which creates the risk of significant disappointment later on in the year.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.